What exactly is an ICO token?

Tokenization often refers to the process of substituting a sensitive data element with a non-sensitive, more secure equivalent, referred to as a token. Just about anything can be “tokenized”— from your payment credentials, to data security, future work that will be done, and more.

“Image

For ICOs, tokens are used to raise money to develop a crypto-related project. The tokens are exchanged for real money, with investors and speculators hoping to receive access to finished products or services on a blockchain or receive revenue at a later date.

How are tokens different than cryptocurrencies?

Tokens are different than crypto-”currencies” and “coins” because tokens are designed with either utility or speculative value in mind, whereas coins and currency are designed for making payments.

Think of coins and currencies as a money equivalent. They define value and transfer value.

Tokens on the other hand are more like a representation of a contract agreement. The value is determined not by crypto mining or market dynamics, but rather by the utility value of the contract written into the token.

“ImageUnlike with cryptocurrencies, you don’t need to develop a new blockchain to create and issue tokens. They can be created on existing smart contract platforms.

In some cases, tokens can take on characteristics similar to currencies/coins and possess utility value along with the ability to define and transfer value. But don’t let this confuse you.

Take Ethereum for example. It was originally designed as a smart contract platform, and while it keeps this design, its tokens (ETH) have also evolved into a currency.

What is a "token contract"?

A token’s contract regulates its transactions, value, and distribution. It defines how the token works and operates on a blockchain according to the terms and conditions of the contract.

To create one of these contracts, all a company needs is a supporting platform. Let’s look at Ethereum again, but more specifically at this platform’s cycle for contract creation:

  1. Token conception: a startup company designs the basic rules for a token, including total amount, value, and any specific conditions or functions. These rules will determine how that token operates on the platform, and the platform then ensures all of these conditions are met and executed. Imagine the blockchain as a bank ledger, a record of all transaction history, and the platform as an intermediary who negotiates contracts between parties.
  2. Token purchase: when somebody wants to buy a token, the token contract needs to first check if there are tokens available, and then decide if the purchasing party has met the conditions to make the purchase. It’s like a vending machine, checking to see if it has enough stock available, and if it has received enough money to give you one of its product.
  3. Token transaction: after somebody has bought a token, the contract then mediates how transactions take place. Token wallets exist on the supporting platform to either store tokens or send them to another wallet. The smart contract will check and then confirm or reject transactions based on its programmed ruleset. When a transaction happens, all of this activity is recorded and updated on the blockchain.

Then there’s one more element to this operating process, and that’s how you pay for transactions. The processing fee will be determined by the platform and the token’s contract, and this fee is called "gas".

Anytime you want to buy or sell tokens, you must pay “gas” to execute the transaction on a blockchain. This fee is not fixed. It is different from platform to platform, and also varies depending on the token’s price and how much you are sending or receiving.

You can pay higher “gas” if you want to speed up your transaction, as the platform usually serves the highest gas-bids first and lower bids at later times. Due to this, some transactions can take longer times to process when there are people who are willing to pay more.

Token classification

Utility tokens

The most common form of crypto-token nowadays is the utility token. This is a token with utility value that allows you access to finished goods or services on the blockchain.

To explain this concept through an analogy, imagine an ICO is like a videogame arcade. The company is the arcade, and you can play different game machines with the tokens you buy from them.

“Image

Now, to complete the analogy, let’s say that the videogame arcade is not yet officially opened, but the company is offering a special discounted price to anybody who buys tokens before the opening date.

Pretend it’s a two-tokens-for-the-price-of-one deal. But this deal is only available if you buy before the arcade opens.

After opening, the cost of the tokens rises, but you have more value for your money because you bought yours early. You have access to the same video game machines as everybody else, only at a special discounted price.

The concept of the ICO is very much like this. The company sells tokens for the initial funding and development of their product (like the videogame arcade), and you get tokens for use when that product is ready.

Security tokens

Security tokens represent a claim on a specific cash-flow or off-chain asset. In this way, they are very much like equity in an IPO, and can provide holders with benefits like dividends, profit shares, or voting rights.

The Howey Test, created by the US Supreme Court, is used to determine whether certain transactions qualify as “investment contracts.” The transaction will be deemed as an investment when it fulfills the following criteria:

  1. It is an investment of money.
  2. The investment is in a common enterprise.
  3. There is an expectation of profit from the work of the promoters or the third party.

If the token does count as an investment and derives its value from an external, tradeable asset, it is deemed a security and thus subject to federal securities and regulations.

Due to the legal requirements, launching a security token can be a time-consuming and resource-heavy process. A company needs advisors, lawyers, regulators, and technical platforms to launch the token for trading.

"Credit" tokens

Credit tokens are often used for a company to raise early capital to launch their product. In this case, an investor agrees to buy an amount of tokens early on, and will later receive an additional percentage of value on their purchase, like “x + 10%” after a given amount of time.

“Multi-purpose” tokens

In some cases, companies may distribute tokens that can fit into multiple classifications. Take Steemit for example. With Steem (STEEM), Steem Dollars (SMD), and Steem Power (SP); this platform provides tokens with utility value, speculative value, and credit value.

Steem is the basic cryptocurrency used to power the whole system. You can buy and sell Steem to speculate on its value, or use Steem to purchase Steem Dollars and Steem Power to use on the platform.

Steem Dollars are like credit tokens that acquire interest the longer you hold onto the tokens. These tokens are only used on the platform. One steem dollar represents the amount of Steem it takes to equal one US dollar. It’s basically a promise to token holders that every one steem dollar will be redeemable for one US dollar’s worth of Steem in the future, but with the promise of interest to people who hold onto their tokens for longer terms.

Steem Power (SP) is like a long-term investment agreement. SP is not easily liquidated into steem, requiring a two-year process to cash out. It also comes with a high interest rate, encouraging users not to liquidate their SP into Steem.

How do I buy, sell, or trade ICO tokens?

The process for buying ICO tokens is the same as what you do with bitcoin or any altcoins. All you need to do is register on an exchange that has listed your token and make a purchase.

One thing you should know, however, is that some ICO tokens will have certain conditions for when you can sell your tokens. For example, your token’s contract may include that tokens can only be sold after a certain date, or after a certain date but only to a specific vendor.

This means you’ll want to do your own research into the token and carefully read the “fine print” in your token’s contract before deciding if the token is right for you.

Share this guide:

Receive Actionable Alerts Today

Whether you are a seasoned trader or a beginner, our Telegram Bot will do all the grunt work so you can focus on making the most informed trading decisions.